INDIAS ECONOMIC REFORMS: LESSONS FOR SOUTH AFRICA

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India, a southern Asian country with a tropical monsoon climate has approximately one thousand million people. An estimated 67% of the working population engages in agriculture that produces mainly rice, wheat, oilseed, cotton, jute, sugarcane potatoes, livestock and fish. It is the worlds largest democracy and the second most populous after China and comprises an area of one-third the size of the US. The country has diverse ethnic groups and religious beliefs. They speak many languages of which Hindi is the most common, followed by 14 other official languages. The country became independent from Britain in 1947 when its eastern and western parts were split to form West and East Pakistan. The economic development of India after independence can broadly be described in terms of two main periods. Although these periods could be sub-divided into different sub-periods our exposition will adhere to the two main periods. The Indian-socialist period This period starts after independence and lasts to the end of the 1970s. The proportion of the population below the poverty line increased during this period from 45% in 1951 to 47% in 1979. During this period real GDP growth was 3.5% p.a. on average with per capita income expanding at a rate of 1.3% p.a. Modern manufacturing was the main source of economic growth, rising from 17% in the beginning to 19.4% of GDP towards the end of the period. State socialism developed rapidly and the governments share in gross capital formation amounted to almost 54% during the early 1960s. Government dominated the economy with monopoly enterprises that were grossly inefficient. Economic activity in the private sector was extensively regulated through controls and licensing requirements for investment, agriculture, imports and exports. The labour market became highly regulated and large firms were required to seek government permission for retrenchment. The result was that the production process became highly capital intensive. Moreover, government controls added significantly to production cost in the private sector. The high oil price during the oil crisis of the 1970s complicated the situation. Indias growth performance plummeted to the bottom of the global growth league. Owing to these depressing circumstances government started introducing economic reforms on a limited scale during the late 1970s that were carried through to the 1980s. Certain controls on production and investment in manufacturing industry were abandoned followed by some liberalisation in respect of international trade. The latter was mainly concerned with fewer controls on exports and the import of capital goods. The changing policy orientation and a more market friendly approach by government triggered an economic recovery. These early reforms, although limited in scope, were important in the sense that they carried a great deal of credibility while they focused on key areas of economic performance. Investment recovered and owing to the greater access to quality imported machinery the investment process was driven by the introduction of machinery and

Dr. C. Bruggemans made helpful comments on an earlier draft. The usual disclaimer applies. 1

equipment. This process was further stimulated by slower oil price increases. On the demand side the economy was stimulated by a rising fiscal deficit. The Bharatiya growth period This period started during the early 1980s and achieved high growth rates during the 1990s following the introduction of a new policy framework. During this period (19802003) real economic growth averaged 5.7% p.a. as opposed to the average 3.5% p.a. of the Indian socialist period, also referred to as the Hindu rate of growth. This period is characterised by the recognition of the harmful effects of extensive government intervention in the economy. The changing attitude of government was further encouraged by a combination of devastating developments. There was the oil price hike owing to the gulf war of 1991. The Indian balance of payments problem rapidly escalated into a full-blown crisis. The earlier reforms, mentioned above, went hand in hand with a rising gap between exports and imports that were financed by external borrowing. Foreign debt rose from 17.7% of GDP in 1984/85 to 24.5% towards the end of the 1980s. As indicated above, the economic expansion was supported by government expenditure. Unfortunately the fiscal deficit deteriorated markedly to 10% of GDP in the early 1990s. Spending on defence, interest payments, subsidies and wages mainly fueled government expenditure. Economic reforms became an imperative and the extent of the problems encouraged government to adopt far-reaching reforms. The abolition of licensing and the termination of price controls were followed by a substitution of tariffs for import licensing. Tax rates were reduced. An example of excessive taxation was the more than 100% marginal rate on income from assets inclusive of the wealth tax. Trade liberalisation followed and the economy reacted very favourably with a marked increase in private fixed investment expenditure. The rupee was devalued and the budget deficit reduced. A market-related foreign exchange market was introduced. Large inflows of foreign capital followed and relieved the balance of payments problem. The foreign debt ratios improved while exports recovered markedly. Owing to the foreign capital inflows and large exports the foreign exchange reserves accumulated fast and this liquidity built-up became an important inflation danger. Unfortunately the boom petered out towards 1997. The slowdown in economic expansion is explained by the fact that the authorities did not show a sustained commitment in support of the reform process. Private sector growth initiatives lost momentum and the economic expansion slowed down. Furthermore, reforms did not go far enough, probably because of a lack of public commitment. The rigid labour market of the Indian socialist period was still a serious problem. Minimum wages and regulations regarding the capital-labour ratio for firms discouraged employment. Tariff rates were still among the highest in the world. There was also a lack of reform in agriculture and state monopolies were unable to provide a consistent supply of electricity. Poor governance in the public sector was a major reason for the discouraged growth performance. Poor service delivery was evident by public monopolies such as railways and electricity. Moreover, the provision of public goods deteriorated because of poor governance in the following areas: law and order, courts, police, roads, public health care, public education and rural infrastructure. Despite the reforms governments share in GDP remained at a high level and increased markedly towards the end of the 1990s, particularly because of excessive increase in public sector wages. The rigid labour market inhibited an expansion in Indias manufacturing sector. This is an important difference between Chinese and Indian economic development. The outcome of this is that India finds it increasingly difficult to deal with its high

unemployment rate. In India manufacturing amounts to 16% of GDP as opposed to 35% in China. Probably because of the lack of a dynamic manufacturing sector the Indian economy responded by creating a relatively large service sector, comprising 48% of GDP. This has given India a competitive advantage in information technology. Nevertheless, the size of the service sector in India does not appear to be in excess of the international norm for countries with a similar GDP per capita level. Lessons for South Africa The Indian economy reacted favourably to the economic reforms that were introduced during different periods but economic growth soon lost its momentum. The main reason for this is that the reforms were not sustainable. The authorities were either reluctant to liberate the economy in a meaningful way or they lacked commitment to implement the reforms successfully. Moreover, the economy remained burdened by a large bureaucracy. High unemployment and a slow growing economy became prominent features and Indian economic development was disappointing. South Africa has experienced substantial economic reforms since 1994 and in many instances these reforms were building on the reforms that were introduced since the second half of the 1970s. Unfortunately the South African government has not implemented the reforms consistently. Many reforms were not completed while others are still lagging behind. In a similar way as in India the labour market remains rigid and particularly discriminating against outsiders. The unemployment rate is very high while the economy is becoming capital intensive in terms of production. Examples of unfinished reforms are the foreign exchange market, privatisation and the opening up of the economy to international trade. Reforms in the area of human capital development such as education and public health care are lagging behind. Moreover, controls and bureaucratic arrangements are gradually rising. The outcome of this is that the economic growth rate is not optimal while unemployment remains high. Going by the Indian experience it appears that economic reforms bring substantial benefits but they should be conducted systematically and consistently. Summary and conclusion This exposition shows that Indias economic development has been hampered by poor economic policies and socialist inspired economic models that did not work. Economic reforms were showing results but they were not carried out far enough. Their implementation was hampered by governments with little enthusiasm for market related reforms. The outcome of this is that India has slipped back into a Bharatiya growth pattern and without more liberalisation the country is unlikely to generate growth rates in excess of the present 6% p.a. The authorities are hoping to achieve a growth rate of 10% p.a. Owing to poor reform policies, Indias manufacturing industry is lagging behind and consequently the country suffers a high rate of unemployment. This is likely to remain so for the foreseeable future. The competitive IT services sector is unlikely to relieve the unemployment pressure because it depends on skilled labour. Moreover, its output is presently less than 1% of GDP. Indias Congress Party, known for its hesitation to embrace market-oriented economic policies, leads the present coalition government. In the foreseeable future India is unlikely to make sustained progress towards a more balanced economic development

that could relieve the unemployment pressure while generating higher economic growth rates. Glenheath Ruiterbos 15 March 2005 REFERENCES ACHARYA, S. (2001) Indias Macroeconomic Management in the Nineties, New Delhi: Indian Council for Research on International Economic Relations. BOGLER, D. (2004) Indias Quiet Revolution Continues, London Financial Times, 16 Nov., www.ft.com. JOSHI, V. (2004) The Myth of Indias Outsourcing Boom, London Financial Times, 16 Nov., www.ft.com. LINDOW, K AND FELDBAUM-VIDRA, J. (2004) India, Analysis March, Moodys Investors Service, Global Credit Research. PANAGARIYA, A. (2004) India in the 1980s and 1990s: Triumph of Reforms. IMF Working Paper WP/04/43, Washington, D.C.: IMF VIRMANI, A. (2004) Indias Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper 122, New Delhi: Indian Council for Research on International Economic Relations.